Also known as second mortgages, home equity loans let you borrow money based on the equity that you have in your home. Understanding how home equity loan qualifications work will help you know when to take advantage of and when you should consider other options if you need to borrow money.
There are different types of home equity loans available. It is important to know what they are, to best determine the right one for your needs.
Home Equity Loans are Fixed-Rate Loans
A home equity loan is when you are paid a lump sum and then is repaid over the time set in the loan itself. The payments you make each month along with the interest remain the same over the lifetime of the loan.
- Easy to understand source of money
- Fixed Interest Rate: often lower compared to credit cards and personal loans
- Consolidates debt into one loan
Perhaps the most common reason why a fixed-rate loan is so popular is that it consolidates other debts, such as from credit cards, into a single monthly payment at a lower interest rate.
- Bad for Repeat Borrowers: Continues cycle of borrowing to pay off borrowed money
Often called “reloading” by lenders, it is the practice of paying off debt by taking out another loan to pay off the debt. This cycle can repeat until the borrower can’t pay back the loan and loses the property. Home equity loans are a great way to pay off debt with a higher interest rate, such as credit cards. The problem starts when the second mortgages approach the total equity built up on the property.
Home Improvement Loans
This is another potential issue when you borrow too much to cover changes to the home that are not necessary. It’s one thing to take out a fixed-rate loan to repair your home or add something that improves the overall value, such as a new roof or improved kitchen or bathroom. It is another thing to use the money for a swimming pool or other type of vanity addition that does not improve the overall value of the property.
A simple way to determine if taking out a fixed-rate loan for a home improvement is worth the cost, all you need to do is determine whether the changes add up to a greater value than covers what is spent. In most instances, you’ll find that a new pool or deck does not provide any real improvement. However, fixing up a kitchen or bathroom that needs work could be the right thing.
Best Way to Use Home Equity Loans
Although the fixed-rate has advantages over other types of loans, they are best used for specific reasons as you are putting the property up for collateral purposes. For most homeowners, the time to take out a fixed-rate loan on your property is best used for the following;
- Combine All Debt into One Monthly Payment
- Cover Cost of Significant Payment: A new roof, unexpected medical bill, and the like
As with any loan, you should only take it out if you have the means to pay it back. A good, steady source of income from your job or business means you can take out a second mortgage with more confidence.
Lenders Like Fixed-Rate Loans
For the lender, a home equity loan is quite attractive for several reasons. Assuming it is the same lender that made the original loan, they essentially get to extend it after earning the fees and interest from the first mortgage. If the homeowner defaults on the loan, then the lender can keep all the money earned from the first and second mortgage they have made plus the property itself.
Once they are in possession of the property, they can start the process again with a new borrower. For lenders, this is a “win-win” situation no matter the outcome. This is also why lenders are more eager to make such loans. They are based on the property itself and not the credit rating of the borrower.
Should You Take Out a Home Equity Loan?
The answer will depend on how the money is used and if it is the best option. The advantages of a home equity loan are considerable! But, remember that your property is at risk if you do not pay it back. That is why using it to pay off your credit cards and high-interest loans is best. That way you have one monthly payment at a lower interest rate.
You will need to fully understand the terms of the fixed-rate loan, the length, and how much it will affect your budget before you make the commitment. It is also advisable to talk to a mortgage consultant like Grupo Gap, to see if there are other, better options available before you take out a home equity loan. Contact us today for a one-hour free consultation!